Comments in financial statements of three charities appealing California AG’s Cease and Desist Order. Part 3 of 3.

Appeals of the AG’s C&D Order will be heard by an administrative law judge. Image courtesy of Adobe Stock.

There are a number of pieces of information of public interest in the most recent financial statements for the three charities who received cease and desist orders from the California Attorney General. The appeal hearings start in a week, on November 27, 2018.

Part 1 of this series provided background, an executive summary, and a short discussion of Catholic Medical Mission Board’s disclosed accounting policy. Part 2 discussed the Food for the Poor financials.

This post will discuss the MAP International financials. Might want to get a fresh cup of coffee since this is a long read because it quotes the accounting policy in 2017 and 2016 along with a transition comment from the 2014 financials.

Previous post discussed the 12/31/16 financials for FftP, 9/30/17 financials for CMMB, and 9/30/16 financials for MAP.  FftP and MAP have since issued their next year’s report; CMMB has not.

MAP International

The 9/30/16 financials were available for issue on February 2, 2017, about 4 months after year-end.

The audited financials for the year ending September 30, 2017 have a date on the audit report of September 27, 2018. That means the 9/30/17 financials were released, or available for issue, on 9/27/18, about twelve months after the fiscal year-end. Audit report is from the Lawrenceville, Georgia office of Capin Crouse.

This means the 2017 financials were prepared with knowledge of the AG’s allegations and known status of the case as of September 2018.

MAP discloses it is using wholesale acquisition cost as found in the “Red Book” for valuing donated medicine. There are four paragraphs in the 2017 financial statements that address valuation of donated medicine. Since it is of public interest and highly relevant to the upcoming appeal, here is an extended quote from note 2 on accounting policies with the full paragraphs included for context:

Gifts-in-kind of medicines and medical supplies are recorded as inventory and contribution revenue at its estimated fair value at the date of donation. All donated inventory is received from private organizations, and is considered to be unrestricted support unless the gift explicitly contains donor restrictions. MAP only records the value of donated inventory in which MAP was either the original recipient of the gift, MAP was involved in partnership with another organization for distribution of the inventory internationally, or the inventory was used in MAP’s programs.

MAP estimates the fair value of donated inventory as of the date received. To determine fair value for donations where the U.S. is the principal or most advantageous market within the meaning of U.S. generally accepted accounting principles, MAP begins with wholesale acquisition cost (“WAC”) and may discount such pricing based on inventory condition, transactional data, and other factors within MAP’s judgment and discretion. WAC is defined in federal law as the manufacturer’s list price for the drug to wholesalers or direct purchasers, not including prompt pay or other discounts, rebates, or reductions, for the most recent month for which information is available.

MAP uses published industry information regarding WAC, primarily Thomson Reuter’s “Red Book,” which is a pharmaceutical industry recognized drug and pricing reference guide for pharmaceuticals in the United States. For products not available in the Red Book, the fair value is estimated using publicly available pricing sources, including where the U.S. is not the principal market or the most advantageous market.

When MAP receives donated inventory with specific geographic or purpose restrictions, they are recognized as temporarily restricted contributions. Donor restrictions are satisfied, and donated inventory is released from restriction and reclassified as unrestricted, when the donated product has been shipped. When MAP receives donated inventory with legal limitations (e.g., non-FDA approved drugs, which cannot be distributed within the United States), they are considered limitations, rather than purpose restrictions, and therefore are reported as unrestricted contributions.

The disclosures in 2017 were revised from the comments in 2016. As mentioned above, the 9/30/16 financials were available for issue on February 2, 2017. For contrast of the disclosures in the two years, here is the verbatim explanation of valuation for donated meds, quoted for public interest and so readers may see the changes:

Donated inventory (consisting of medicines and medical supplies) is recorded as inventory and contribution revenue at its estimated fair value at the date of donation, taking into consideration inventory condition and utility for use. All donated inventory is received from private organizations and is considered to be unrestricted support unless the inventory explicitly contains donor restrictions. MAP only records the value of donated inventory in which they were either the original recipient of the gift, were involved in partnership with another organization for distribution internationally, or used in MAP’s programs.

MAP has determined the estimated fair value of donated inventory in accordance with fair value measurement accounting standards using WAC. WAC is considered to more closely approximate fair value as it is self-reported by manufacturers. While WAC is not based on actual sales transactions, it is defined in the Social Security Act: “Section 1847A(c)(6)(B) of the Act defines WAC as the manufacturer’s list price for the drug to wholesalers or direct purchasers, not including prompt pay or other discounts, rebates, or reductions, for the most recent month for which information is available.”

WAC is the undiscounted list price that manufacturers report to publishing companies, such as First DataBank and Thompson Reuters, which use these data to produce pricing compendia. The price wholesalers charge pharmacies for a drug is generally based on WAC. In a similar way, MAP determines fair value from the WAC values published in Redbook© Online by Thomson Reuters.

Inventory items not listed in Redbook© have been valued according to an average of current market data derived from international pricing to obtain a reasonable fair market value. For donations that originated from countries with validated pricing information, the pricing information of the respective country was used to determine fair value.

When MAP receives donated inventories with specific geographic or purpose restrictions, they are recognized as temporarily restricted contributions. Donor restrictions are satisfied, and donated inventory is released from restriction and reclassified as unrestricted, when the donated product has been shipped. Donated inventories received with conditions, such as the provision that they cannot be distributed within the United States, are considered limitations rather than purpose restrictions; therefore, they are reported as unrestricted contributions.

The September 30, 2014 financial statements have the same comments as in 2016, with a couple of minor wording differences.  The 9/30/14 financials were available for issue on January 22, 2015. The main change from 2014 to 2016 was removing the following paragraph, which was included in 2014 but obviously not present in 2016. The comment was included between the first and second paragraphs in the comment above. Due to public interest, the paragraph is quoted verbatim:

During the past several years, MAP along with other relief and development organizations has moved from the use of medical industry information referred to as Average Wholesale Price (AWP) in determining the fair value of donated inventory. This is due to changes in accounting standards and in the source medical industry market information.

Note 11 in the 2017 financials describes commitments and contingencies. Because of the public interest and as an indication of MAP’s position, here is a quote of the full paragraph:

MAP is involved in administrative proceedings with the California Attorney General (AG). The AGʼs office is seeking penalties and fines of at least $158,875. MAP denies any liability, and intends vigorously to defend. The ultimate liability, if any, cannot be determined at this time because considerable uncertainties exist. However, based on the facts currently available, management believes that the ultimate outcome of matters that are pending or asserted will not have a materially adverse effect on MAP’s financial position. Accordingly, no adjustment has been made to reflect the amounts sought by the AG.

That comment has far less detail than FftP.  Magnitude of the contingent liability is about ten times higher for FftP than MAP so it makes sense there would be less discussion. In addition, there is no indication which is publicly visible that any AGs other than in California are focused on MAP, which is another reason the MAP disclosures are shorter than FftP.

Consider materiality in relation to total revenue of $598.4M for 2017, of which cash revenue is about $13.1M.  On one hand it could be argued a contingent liability of $0.16M is so immaterial that it does not warrant discussion based on being quantitatively immaterial.  On the other hand, the liability and implications of the allegations from the AG sure do seem to be qualitatively material. Likelihood, based on the note, is indeterminate.

On the other, other hand, likely interest from readers of the financial statements is sufficiently high that MAP has to address the issue. Lack of any comment in notes addressing the AG’s enforcement action would have raised questions in the mind of informed readers. The interest by some readers makes the issue material, regardless of the dollar amount.

(Technical learning point for auditors: The preceding comment that some number of readers will be concerned about the issue and their concern means the issue should be discussed is a great illustration of the core meaning of materiality. Phrased differently, an assessment of immaterial liability by management is material information to readers.)

Full disclosure: I worked in the California office of Capin Crouse from 1989 through 2002. I don’t recall ever having worked on the MAP audit. Don’t remember for sure if it was a client of Capin Crouse back then, but think that it was for the last few years I was with the firm. I don’t know who the senior staff are on the audit now, but will guess I know some of them.

Previous posts in this series:

  • Part 1: Background, executive summary, and comments on Catholic Medical Mission Board financials.
  • Part 2: Comments on Food for the Poor financials.

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